Savour International

Interview with Andreas Feller, Head of Wealth Management Solutions Bank Vontobel

We are carrying the risk expertise we have built up in Investment Banking over to Private Banking.

Today's financial world is extremely complex, and the risk models were quite simply not capable of flagging up the worst-case scenarios properly. Modern work psychology states that business decisions are based primarily - but not exclusively - on experience. The two other deciding factors are confidence and, as clichéd as it may seem, hope. In the present situation, this process has failed completely. So what happened? It all started with people in the US who could no longer keep up their mortgage payments. This is something that had never happened before as US consumers have in the past always met their obligations as regards paying for their homes; as a rule, they have defaulted first on their consumer loan repayments. It is precisely this historical scenario that the risk models were geared to. As a result, there were no warning signals, since default rates on consumer loans and credit card debts did not rise, and, based on past experience, the mortgage market appeared to be in good shape. However, as we have since found out, it was not.

Have we learned anything from this?

From a short-term perspective, yes, I think we have. Investors' risk aversion, at least, has increased markedly, and more is being invested in capital protection products again, for example. That said, we must not be under any delusions: another crisis will surely come along sooner or later, and the banks' task will be to check their processes and instruments with regard to hidden risks linked to the worst-case scenario and tailor their financial products perfectly to clients' needs. The focus in future will once again be more on risk and less on returns, and that is likely to be the biggest lesson we have learned from the subprime debacle.

Is your bank affected by the subprime crisis?

As a private bank rich in tradition with a business model aimed at sustainable growth, the Vontobel Group has no direct exposure to the US mortgage market either on its own books or in client portfolios. Nevertheless, the turmoil on the international financial markets in the second half of 2007 posed a challenge for us as an active market player. However, our far-sighted strategy and rigorous risk management allowed us to control and minimise the impact on our business. We are systematically transferring this risk expertise, which we have built up in Investment Banking, to Private Banking.

Risk expertise in Private Banking sounds good. What exactly do you mean by this?

The main aim here is to get clients more sensitised again to the risk associated with certain return expectations. To this end, we always start our client consultations by discussing the client's risk capacity in terms of his or her assets and attitude towards investment strategies that promise high returns but also involve corresponding risks. Only when these points have been clarified do we start talking about return expectations. Experience shows that, as a rule, focusing primarily on performance puts you on a road to nowhere. Who would be satisfied with a 4% return on their investments when the equity index has gained 30%? It is our task, therefore, to carry out a comprehensive analysis of our clients' risk capacity, make a precise record of it based on their current circumstances and finances, and derive individual investment decisions on this basis. We can only claim to have done our homework when clients understand the relationships between potential returns and risks. We often discover, for instance, that private clients could take on much more risk in purely mathematical terms but are unable to do so on an emotional level. This is a crucial point. If you are not aware of it, you will focus too much on the return side, forcing yourself into a procyclical stance and following the herd. This will result in poor investment returns over the long term.

That would be presumptuous. However, we are aware that all good things come to an end, which is why we employ the concept of mean reversion (returning to the medium-term trend). If a position moves two to three standard deviations away from the average, we react by either buying or selling.

Can you illustrate this with an example?

We reduced our equity weighting in the last quarter of 2007 and have only recently started making selected purchases again. Unfortunately, we can never catch the exact high or low point, but this method does allow us to smooth out portfolio volatility to a significant extent.

And how are you dealing with the increase in volatility?

We are exploiting it through targeted use of structured products that sell volatility while also providing a certain amount of capital protection. This way, we can build a certain "comfort zone" into portfolios. In other words, we are exposed to the market, but we have an airbag, so to speak. We are only in the same boat as everyone else if the worst comes to the worst. However, we are very cautious in setting our barriers, keeping to an index step of 30-40%. We also assign all products to the worst-case scenario. That protects us against unpleasant surprises on the downside.

The concept sounds logical. What do you have to bear in mind?

Many clients tend to have accounts with several banks and keep them all separate. That is exactly where we see the biggest risks. Not viewing your assets from a consolidated, holistic perspective means that you do not know the risk and return drivers behind your investments. A bond fund, for instance, is not necessarily a safe haven. The opportunities for investing these days are unlimited. As a result, asset flows are accentuated and occasionally culminate in short-term exaggerations that can even spill over into megatrends such as alternative energy or water. Here, too, the important thing is to sell high and buy low. We must therefore be prepared for increased volatility and actively exploit it.

This entails a lot of opportunities and risks, and it is the risks that should always be the focus - on a consolidated basis for a client's entire assets, regardless of how many banks they are held with.

Mr Feller, thank you very much for talking to us. Savour Magazine